Do Incentive Trusts Work?

Using Trust Distributions to Encourage Behavior

Dangling a Carrot

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How do you get your kids to do what you want? Any parent will tell you that it's hard enough when children are small and only gets tougher as they grow up. Nevertheless, many people try to use the purse-strings to control their kids. How many children, teenagers, and even mature adults have been threatened with disinheritance? While occasionally a child is cut completely out of the will, most parents are reluctant to take that extreme step. There is, however, another alternative.

Incentive Trusts

The use of an “incentive trust” has become a popular topic for discussion among estate planning professionals and their clients. Incentive provisions in a trust are designed to encourage particular behaviors, address specific problems, or promote a general philosophy of life. The incentive offered is financial. If the trust beneficiary exhibits the desired behavior, then he or she receives more money from the trust. (In some circles that’s called bribery.)

Sometimes the trust includes a general statement that includes the philosophy of the parents. The trustee is then directed by this statement of philosophy in exercising its discretion. For example, the trustee may be directed not to make any trust distributions that would remove the incentive for a beneficiary to be self-supporting. Sometimes there are objective standards for the Trustee to monitor that will govern distributions. Some standards suggest that trust distributions should equal earned income. The more you earn, the more you get from the trust.

Many wealthy clients express concern that leaving too much inheritance to their children will “spoil” them. They are concerned that a child will not work as hard to make personal achievements, and that having too much money will keep the child from becoming a productive member of society. There are many such children who are “professional heirs” and who do nothing but live lavishly on their inherited wealth.

The "Perfect Inheritance"

The simple solution to this problem is not to leave everything to children. As Warren Buffet said, the perfect inheritance is “enough money so that they feel that they could do anything, but not so much that they could do nothing.” Anything over the “perfect inheritance” would be given to charity or other beneficiaries.

For many clients, the most important thing is that a child is involved in productive employment. This is simple to say, but not so easy to draft into a trust document.

  • What if the child is in school?
  • What if the child is disabled because of injuries or illness?
  • What if the child is staying home to raise a family?
  • What if the child is performing volunteer services?
  • What if a child is the care-giver for an elderly parent?
  • What if there is an economic recession and the number of jobs available is severely reduced?    

All of these possibilities and more must be addressed in the document.

It is impossible to predict what the future will bring and what special circumstances may involve a trust beneficiary. These types of trust are very difficult to draft, but even more difficult to administer. The Trustee is given a much more difficult task than usual. To monitor objective criteria, the Trustee must obtain and analyze income tax returns, medical reports, economic circumstances, and much more. The Trustee will need broad power to investigate the beneficiary's circumstances and request objective proof that beneficiaries are entitled.

Who Can be The Trustee?

The parents may have siblings or friends who can be a Trustee for a while, but children and grandchildren will most likely live longer than these individuals. It seems that a corporate fiduciary must be considered, at least as a successor to named individuals. Any Trustee who accepts this type of responsibility will want to make sure that the trust instrument provides liability protection. Any Trustee would be concerned about a trust beneficiary who is homeless because the conditions for trust distributions haven’t been met.

Many other objectives could be sought with an incentive trust. The possibilities are as endless as the imagination. It isn’t hard to imagine clients who would like to condition inheritances on a child not marrying a certain individual. Or on a child not divorcing. Inheritance could be conditioned on one becoming a doctor or lawyer, or not becoming a lawyer, as the case may be. The incentive could relate to religion, place of residence, number of children, length of hair, color of clothes - what would be the limit?

Does an Incentive Trust Work? 

Someone who inherits an incentive trust may or may not be incentivized by it. It all depends on the person. Discuss the trust with the person who is the beneficiary. Make sure they understand the rules of how they're able to receive the money and if there are any caveats they need to know. Let them ask questions and explain your reasoning to them. If you're on the same page, an incentive trust can work.

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  1.  Carol Loomis. “Tap Dancing to Work,” Page 318. Portfolio/Penguin, 2013.

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